Many start-up companies face constant challenges to recruit talent and grow their company without access to much working capital. One available tool to recruit and retain key employees without incurring too much overheads and at the same time motivating these employees is using an employee share option scheme (ESOS). Through the promise and eventual ownership of shares in the company, the employees have a vested interest in growth and success of the company. In this Part 1, we explore the basic mechanics/terms of how an ESOS works and also some regulatory aspects.
What is an Employee Share Option Scheme “ESOS”?
It is a scheme introduced by the employer company that issues a share option to eligible employees by giving them the contractual right to acquire shares of the company in the future at a pre-determined preferential price, normally referred to as the “offer price” or “exercise price”.
Is an ESOS the only scheme to incentivize employees?
No, there are other schemes to incentivise employees through participation in the growth of the company. For example: Employee Share Purchase Plan, Share Award Scheme, Share Appreciation Rights Scheme, Warrant Scheme.
How can ESOS help my company?
ESOS is often used as a tool to motivate employees. By granting rights to own shares (or purchasing shares at a low price), employees feel a sense of belonging and ownership in the company and will potentially be able to tag along with the increased valuation of the company, if and when the shares are disposed (for example, upon listing or acquisition of the company). ESOS could also reduce the burden of cash flow on the company to pay out cash bonuses or high salaries.
Who can receive these share options?
Employees and founders of a company. These share options are mostly granted to key employees which form part of their remuneration.
What are the important dates & terms to be noted in an ESOS?
This is the date that employer company grants the employees the option to purchase shares in a company. This is also known as ‘offer date’ or ‘award date’. A grant of options to the employee usually does not require the employee to make any payment until exercise (see exercise price)
Vesting period is the period between the Offer Date and the Vesting Date, being the period over which an employee has to meet the conditions (if any) imposed by the ESOS by laws in order for the option to vest and become exercisable.
The very first day, upon the options having vested, that an employee is entitled to exercise the share option to purchase shares in a company at the exercise price. The ‘exercisable date’ is also known as the ‘vesting date’. Once the option has vested or become exercisable, it typically cannot be withdrawn by the company, subject to certain exceptions (for example, termination of employment / breach of contract).
The exercisable period is from the first day the option becomes exercisable to the last day the option can be exercised. Typically, when the exercisable period ends and if the option is not exercised, the option will expire.
The date when an employee actually elects to exercise his share option and is allowed to purchase actual shares in the company at the agreed exercise price
The price per share at which the employee must pay to the company to purchase the each share under the option.
Start-up ABC offered its chief technology officer Abu a share option to acquire 10,000 shares in the company on 31.3.2012 at the offer/exercise price of RM1.00 per share within 3 years from 1.1.2013 until 1.1.2016 (exercisable period) if the options have vested.
However, the terms of the ESOS state that Abu’s options will only vest if on or before 1.1.2013, (i) the company achieves an annual turnover of RM200m and (ii) Abu is still employed by the company (these are examples of conditions/milestones attached to the option which determine whether the options vests or not).
By financial year end 31.12.2012, the company achieved a turnover of RM250m (hence, the options have vested) and Abu remained as an employee. Abu then exercises all his share options on 31.3.2014 by paying RM10,000 (ie, at RM1.00 per share) to the company in exchange for 10,000 shares in the company.
Are share options “securities” under the Malaysian securities laws?
Yes. “Securities” are widely defined under the Capital Markets and Services Act 2007 (“CMSA”) to include any option or interest or right in respect of shares of a body corporate.
To issue ESOS, does the company needs an approval, authorization, registration or file a prospectus with the Securities Commission?
Public companies that are issuing bonus shares, employee share schemes and ESOS no longer require the approval of the Securities Commission (SC). However, the regulatory parameters governing bonus issues and ESOS proposals are now administered by Malaysia Securities Exchange Berhad (MSEB).
ESOS of a Malaysian private company does not trigger the SC approval requirements under s212(2),(3),(4) or (6). ESOS in an unlisted private company could arguably fall within the wide definition of ‘unlisted capital market product’ and potentially trigger the SC authorization (s212(5)(a) and registration requirements (s212(5)(b)). However, we are of the view that an ESOS of a private unlisted company is excluded from s212(6) by virtue of s212(8) and Schedule 5. Also, the implementation of an ESOS should not trigger the Division 3 prospectus requirements under s229 of the CMSA, being excluded offers or excluded invitations under Schedule 6.
Are there any requirements under the Companies Act when the company issues ESOS?
Apart from the tax reporting obligations (which will be discussed in PART 2), s68A of the Malaysian Companies Act 1965 requires the company to keep a register of options granted to persons to take up unissued shares in the company. The company must update such a register with details of the ESOS terms within 14 days of any grant and failure to comply will be an offence attracting penalties under the Act.
About the Authors: This article was written by Shawn Ho with assistance from Yuna Cheah. Shawn Ho is a partner of Donovan & Ho and is experienced in corporate matters such as acquisitions, cross-border transactions, restructuring exercises, sale of businesses, joint venture arrangements, shareholder agreements, and franchise businesses. His background in tax advisory has enabled him to assist several multi-national companies achieve considerable tax-savings through cross-border tax planning, implementing tax-efficient structures using Labuan companies, and incorporate tax advice into commercial transactions.